There’s no right way to fix the progressive tax

Several months ago, I warned that taxes are not the issue of our time. While some of the details of this new tax plan, particularly on the corporate side, seem promising, the vagueness of details on the individual side continues to prove that reforming the existing progressive tax code from within rather than abolishing it will always remain an elusive accomplishment.

The inherent challenges of reforming the tax code for individuals

As much as we complain about the convoluted nature of the current system, there is a method to its madness. Much of what we have in place is needed — if, and only if, you agree to the premises that 1) We need to maintain or exacerbate the progressivity, and 2) We can’t lose too much revenue in a static analysis. Once we agree to those premises, which Republicans have clearly agreed to, not much good can come out of changing the individual tax code that is worth the political capital we will risk. We will continue to make the bottom half of the code more progressive. And while we don’t like deductions in a vacuum, once they are there, any attempt to abolish them would require a significant rate cut for those who actually pay a substantial amount in taxes. But because Republicans are worried about budget scoring and class warfare, they are probably too scared to do this.

There is no “better” way to design a progressive, redistributive income tax. The convoluted nature is a feature, not a bug. Thus, in my view, we should either go big — abolish the 16th Amendment and replace it with a consumption-based tax (or other innovative ideas) — or go small — just lower all seven existing rates without touching deductions, and target certain unpopular parts of the code individually. Anything else, I fear, will just aggravate the current dynamic.

The top 1% pay 39.5% of the income taxes, even though they earn 20.6% of the income.

The top 5% pay 60% of the income taxes, even though they earn 36% of the income.

The top 10% pay 71% of the income taxes, even though they earn 47% of the income.

The bottom 50% pay just 2.7% of income taxes, even though they earn a greater share — 11.2% — of the income.

Thus, if there is a fairness argument to be made, it’s the opposite of the one propagated by the political class.

Furthermore, this doesn’t take into account the fact that, aside from being eligible for welfare programs, those at the bottom get refundable tax credits that result in a net negative income tax liability — they get money from the tax code. The massive growth of the refundable tax credits, in conjunction with the Bush and Reagan tax cuts, has actually made the code much more progressive today than it was decades ago.

Were we to ask any number of center-right Republicans whether this code is fair and pro-growth, they would all adamantly say “no.” Thus, the reality is that any true tax reform that flattened out the code would result in people at the bottom paying minimally more (or receiving less) and those at the top paying slightly less, albeit still much more than those at the bottom. Yet it’s clear there is no appetite in Washington to do this. Thus, any effort to reform the code always runs into the same pitfall and winds up making it even more progressive.

The devil is not only in the details, but the micro-details

Which brings us to the details of the plan.

The corporate tax changes all seem like they would result in economic growth. But I’m most concerned about the individual tax plan. The new outline would take the current seven marginal tax rates (39.6%, 35%, 33%, 28%, 25%, 15%, 10%) and collapse them into three rates of 35%, 25%, and 12%. The standard deduction would be doubled for individuals and married filers. But on the other hand, almost all itemized deductions (minus the charitable and mortgage interest deductions) would be eliminated, and the personal exemption (roughly $4,050 per person) would be abolished but replaced with some unspecified increase in the child tax credit.

While on paper this sounds nice, it has one big gaping hole. After eight months of touting essentially the same plan, its proponents refuse to give the details on the tax brackets. At what income levels are they drawing the lines? Given that they are getting rid of deductions and the personal exemption, doubling of the standard deduction is meaningless for almost any middle- and upper-middle-income married family who owns a home, in most states. Those families will always itemize deductions, especially conservative ones who give a lot to charities. Thus, this could easily turn into a net tax increase on those families in the 25% and 28% tax brackets — the breadbasket of the GOP base — unless the lines are drawn properly.

However, if the plan kept the 12% bracket up to a relatively high income threshold, that would be a massive tax cut. I’d be all for it, but Republicans have shown signs that this is not their intent. They have opened the door up front for a fourth tax bracket, essentially keeping the 40% rate to “milk the rich” for revenue, and have made it clear that they plan to keep the progressivity, if not make it more progressive.

The document released by the committee chairmen stated the bill’s writers plan to ensure the new plan “is at least as progressive as the existing tax code and does not shift the tax burden from high-income to lower- and middle-income taxpayers.”

Either we are for or against redistribution of wealth. There is no right way to redistribute it or “reform” redistribution. There is also no purpose to randomly collapsing tax brackets. What makes the code complex is not the number of brackets. That is all instantly computed by any free tax software. Collapsing the brackets makes the cutoffs too arbitrary and indiscriminate. They are locking us into this dichotomy where we will have to continue throwing more money at the bottom of the income spectrum and taxing the top. As Trump said in his U.N. speech, “The problem in Venezuela is not that socialism has been poorly implemented, but that socialism has been faithfully implemented.”

This plan is still progressive, but the Left is already attacking it

Don’t get me wrong — I would have never created a system like this. I don’t like the market distortions of deducting state and local taxes and real estate taxes and would love to get rid of this handout to the National Association of Realtors and high-taxed states. But the reality is that those who already pay most of the taxes pay a tremendous amount on net, even after those deductions are factored in. To take them away and raise taxes on typical upper-middle-income families is political malpractice. Democrats are already using it against them. The rate decrease must be commensurate to the lost deductions. The devil is still in the details we don’t have. And don’t forget, these are the families who are already getting hosed by Obamacare and not getting subsidies.

Also, if we are going to continue milking the top of the spectrum for more revenue, how pro-growth will this be, and what is the point to pursuing it? Either way, we will have to incur the fire from the class warfare of the Left. Even if this plan makes the tax code more progressive, the Left will demagogue it. It’s quite evident even from the scant details that this plan will zero out the tax liability of an even larger share of the population, yet it’s already being denounced as cruel. So why not either do it right or don’t touch the issue at all?

Here’s the problem in a nutshell: The progressive tax code will never work for us. It has cemented a baseline that a tax cut is a handout and a handout is a tax cut. For example, say we have two people — one person pays $5 million in taxes, and the other person pays $2,000 in taxes but gets $5,000 in refundable tax credits. Over the years, we have lowered the burden at the bottom to the point where there is no more juice to squeeze out. By definition, any new tax cut in nominal terms will be most evident to those who pay substantial sums, even if the percentage cut is more generous at the bottom. Unless Republicans have the desire and ability to fight through the class warfare, and also not to worry about short-term revenue projections (because they should be cutting spending), the tax issue, on an individual level, is an utter disaster at this point. Republicans should stick with the corporate tax cut and then focus on immigration, national security, debt, health care, and the hidden costs of regulations and market interventions, such as the ethanol mandate, that hurt low- to middle-income families a lot more than the tax code.

This is why I just don’t have my heart in this issue. Remember, once the class warfare intensifies, Republicans will only move this framework further to the Left — throwing more refundables at the bottom and keeping more taxes at the top. And for upper-middle-income families, at best, this will be a wash.

This is the culture of half-assery Republicans have pursued on health care. They incur all of the liabilities of a conservative plan but get none of the policy benefits. Except, unlike with health care, there is no national emergency in the trajectory of the tax code. It has been the same very un-ideal system for a number of years, actually made relatively better by the Bush and Reagan tax cuts. Either go small and reduce all the rates without any games, or go big and push to abolish the 16th Amendment and restructure the tax system in a way that places the states in charge of selecting the revenue for the federal government. Otherwise, just focus on a corporate tax cut while reforming the employer exemption for health insurance, which single-handedly destroyed health care in America. But to “move on from health care” and keep the Obamacare tax on all families, while restructuring the same failed tax code in a way that will pick new winners and losers, is a policy mix only Republicans could concoct.

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Author: Daniel Horowitz

Daniel Horowitz is a senior editor of Conservative Review. Follow him on Twitter @RMConservative.